Severance Tax
A severance tax on natural gas drilled from the Marcellus Shale has become one the most contentious issues in Pennsylvania politics. While the inclusion of a severance tax has been sidestepped by the legislature in the last two state budget processes, this summer Harrisburg promised to vote on a tax in October.
Due to the structure of our state's campaign finance disclosure laws, citizens will not know how much money groups with an interest in Marcellus Shale drilling policy have donated to the campaigns of incumbents until long after a vote has occurred. This is why the Philadelphia Daily News is asking all legislators to voluntarily disclose contributions in the time period leading up to this key vote.
You can view the Daily News' ongoing coverage of their project here, along with their original editorial.
The non-partisan Pennsylvania Budget and Policy Center has released a series of reports regarding a severance tax. As stated on their website, these reports "examined the potential costs of increased natural gas drilling on Pennsylvania taxpayers and the environment, how severance taxes are structured in other states, and what lessons Pennsylvania can learn from them."
The PBPC's most recent report, "How to Structure a Severance Tax that is Fair to Pennsylvanians" (August 30, 2010) focuses on the tax rate and issues such as revenue lost due to delayed implementation during the height of natural gas production (see below chart).
Below is an excerpt of Common Cause Pennsylvania's "Deep Drilling, Deep Pockets" (May 11, 2010) report:
Gov. Ed Rendell has called the Marcellus Shale Pennsylvania’s “golden goose” and described himself as the natural gas industry’s “best ally.” At the same time he has called for levying a severance tax and using 90% of the revenue to fund programs begun under the American Reinvestment and Recovery Act of 2009, while giving 10% to municipalities in which wells are being drilled. Severance taxes are imposed by every major fossil-fuel producing state in the nation and these taxes are typically used to cover costs created by drilling activity. These costs are referred to by economists as “externalities” and include infrastructure wear and tear, safety oversight, emergency response services, and – most of all – the prevention and repair of environmental damage resulting from groundwater contamination, chemical spills, soil erosion, forest fragmentation and habitat loss, and noise and air pollution. Such externalities will impose a significant financial burden on local and state governments. A severance tax would also serve to compensate the state and its residents for the extraction and loss of a limited natural resource, one which drilling operators will sell at a profit.
Drilling companies and other interested parties have from the start scorned the idea of a severance tax, insisting that such a tax would destroy the industry in its formative years. Range Resources vice president Ray Walker, Jr. wrote in a Pittsburgh Post-Gazette editorial that “Imposing the tax on the conventional oil and gas industry would make the development of marginally profitable wells impossible.”
In his 2009-10 budget, Governor Rendell proposed a severance tax of 5% of the sale price and $0.047 per thousand cubic feet of production, a rate that mirrors West Virginia’s successful tax and is modest in relation to other gas-producing states. Texas taxes natural gas at 7.5 percent of the market value while Montana has the highest severance tax of any state, at 15.06 percent. Given current gas prices, the proposed Pennsylvania severance tax would amount to roughly 6.2%. To formulate a tax structure that would not impede the growth of the drilling industry, Rendell sought the input of Governor Joe Manchin III of West Virginia. Manchin assured him that his state’s severance tax did not “inhibit gas extraction and that it is continuing at a record pace,” and that “it's reaping critically needed revenues so the state can provide services to its citizens.”
Rendell estimated the tax would raise $107 million in its first year. But when the 2009-2010 budget emerged after the legislature’s infamous 101-daydeadlock, the severance tax was not included. The result, according to state Rep. Greg Vitali (D., Delaware), was an example of the “same old influential groups getting their way.” Rendell told reporters that the industry had made solid arguments against the tax and that he did not want to slow the “gold rush.” Rendell then proposed the same tax in his 2010-11 budget, estimating that, based on drilling increases over the past year, the tax would raise $160.7 million for FY2010-11 and $475.5 million in FY 2014-15. At a March 2010 industry conference in Fort Worth, Texas, Rendell told the audience that drilling interests currently have “the chance to work with a governor who is pro-industry and who has stood up publicly and fought for the industry” to construct a reasonable severance tax.
The ability of state and local governments to collect tax revenue from natural gas production is marred by exemptions and specific corporate structuring. Landowners leasing drilling rights to operators pay income tax at 3.07% on the royalties they negotiate and receive prior to drilling. But while it is intended that drillers pay the higher 9.9% Pennsylvania corporate net income tax, so many drilling operators and other interested parties are structured as limited liability corporations or limited partnerships that most pay at the far lower personal income tax rate of 3.07%. In fact, a 2009 analysis found that of the roughly 1,500 Marcellus Shale wells active at the time, 70% were operated by LLCs or LPs. Further, in 2002 the state Supreme Court exempted oil and gas from the list of natural resources that may be taxed by municipalities, denying local Pennsylvania governments an essential opportunity to exercise autonomy and collect revenue to offset the costs of a variety of direct and indirect externalities introduced by natural gas drilling. Legislation stalled in the Pennsylvania House of Representatives (HB 10) would reverse this exemption.
